Case Detail

HCIA 3/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

INLAND REVENUE APPEAL NO 3 OF 2010

_________________________

BETWEEN

	COMMISSIONER OF INLAND REVENUE	Appellant
	and
	LI & FUNG (TRADING) LIMITED	Respondent

_________________________

HCMP 541/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 541 OF 2011

(ON AN INTENDED APPEAL FROM HCIA NO 3 OF 2010)

_________________________

BETWEEN

	COMMISSIONER OF INLAND REVENUE	Appellant
	and
	LI & FUNG (TRADING) LIMITED	Respondent

_________________________

CACV 86/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

CIVIL APPEAL NO 86 OF 2010

(ON APPEAL FROM HCIA NO 3 OF 2010)

_________________________

BETWEEN

	COMMISSIONER OF INLAND REVENUE	Appellant
	and
	LI & FUNG (TRADING) LIMITED	Respondent

(Heard Together)

_________________________

Before : Master Levy in Chambers

Date of Hearing : 2-3 December 2013

Date of Handing Down Ruling : 4 March 2014

__________

R U L I N G

__________

A. The preliminary objection

1. In these taxation proceedings, there are altogether 3 bills of costs filed by Li & Fung (Trading) Limited (“LFT”), the party entitled to the payment of the costs of these proceedings, in respectively nos. HCIA3/2010, HCMP541/2011 and CACV86/2011. The party liable to pay the costs in these proceedings is the Commissioner of Inland Revenue (“Commissioner”).

2. A preliminary objection based on Order 62 rule 22(5), Rules of the High Court, was raised in the Commissioner’s List of Objections to the bills. In the objection, the Commissioner asked the taxing authority to deduct globally a percentage of the costs to be taxed in each of these bills of costs on the ground of LFT’s alleged undue delay.

B. The material facts

3. To put the matter in context, it is necessary to briefly summarize the material facts (which are largely undisputed) of these proceedings taken from the detailed chronology of events attached to the Skeleton Submissions of Mr Gilchrist, solicitor for LFT.

4. Broadly stated, the underlying disputes of the parties in these proceedings arose from the Commissioner’s assessment of LFT’s profits tax for various financial years. LFT disagreed with the said assessment, and took the matter further to the Board of Review, against which decision, the Commissioner later made an application for “Stated Case”. The “Stated Case” application was subsequently remitted to the Court of First Instance. This application formed the subject matter of the proceeding in action no HCIA 3/2010 filed on 1 April 2010.

5. After Reyes J dismissed a summons by the Commissioner in HCIA 3/2010 on 28 March 2011, the Commissioner filed an Originating Summons, no. HCMP 541/2011, for leave to appeal to the Court of Appeal, which was later dismissed with costs on 1 April 2011.

6. Proceedings in HCIA 3/2010 were disposed of on 18 April 2011 by Reyes J who ordered the dismissal of the Commissioner’s “Stated Case” application with costs.

7. The Commissioner appealed against Reyes J’s dismissal by filing an appeal, no CACV 86/2011 on 16 May 2011, which appeal was later dismissed by the Court of Appeal on 19 March 2012 with costs.

8. By the deadline date for the application for leave to appeal to the Court of Final Appeal on 16 April 2012, the Commissioner had not filed any application. Thus, by this date, these proceedings were completely concluded.

9. Between April 2012 and October 2012, subsequent to the conclusion of these proceedings, the parties’ legal representatives- according to the correspondence and telephone attendance records Mr Gilchrist submitted to the court – were engaging in “without prejudice” discussions to settle on a global basis of all the outstanding issues concerning the tax assessments and other related tax matters and proceedings.

10. On 4 February 2013, LFT sent to the Commissioner draft bills of costs in respect of the costs orders made in its favour as set out above.

11. On 15 February 2013, LFT filed the Notices of Commencement of Taxation together with the three bills of costs of these proceedings to have the costs awarded to it under the above costs orders taxed.

C. The lengths of delay

12. Relying on Order 62 rule 22(1) which requires a receiving party to commence taxation proceeding within 3 months, the Commissioner’s law costs draftsman (“LCD”) submitted that – based on the calculation of 3 months being the period from the date of the costs orders having been made in these proceedings and the date LFT should have commenced taxation – there have been delays of 22 months, 23 months and 11 months respectively of the bills filed in HCIA 3/2010, HCMP 541/2011 and CACV 86/2011.

13. The LCD, relying on the global percentage deductions for undue delay having been previously made by taxing masters[1] , urged the court to impose the Order 62 rule 22(5) sanction by globally reducing 25% of the costs to be taxed in the bills of costs in both HCIA 3/2010 and HCMP 541/2011 and 10% in CACV 86/2011.

14. The LCD’s calculation of delays by counting from date of the making of the orders nisi (in respect of the costs orders made in HCIA 3/2010 and CACV 86/2011) is not entirely correct. It is because according to Order 62 rule 22(9) sub-sub rules (a) (ii) (in respect of a costs order made in the Court of First Instance) and (b) (ii) (in respect of a costs order made in the Court of Appeal), the “completion date” as specified in Order 62 rule 22(1) should be counted from the date of the making of the costs order absolute (not from the date of the order nisi).

15. Accordingly, the lengths of delay (in respect of the costs orders made in HCIA 3/2010 and CACV 86/2011) – when properly computed in accordance with Order 62 rule 22(9) – should have been, as shown in the table below, 18.5 months and 7.5 months respectively in HCIA 3/2010 and CACV 86/2011. As for HCMP 541/2011, though the date of the order used for the calculation was indeed the date of the order absolute, the LCD has somehow appeared to have rounded up the actual period of delay of 22.5 months to 23 months.

Case No
Date of Absolute Order
Date when taxation should have been commenced under rule 22(1)
Length of Delay

HCIA 3/2010
2/5/2011
2/8/2011
18.5 months

HCMP 541/2011
1/4/2011
15/7/2011
22.5 months

CACV 86/2011
2/4/2012
2/7/2012
7.5 months

D. Reasons for the delay

16. Mr Gilchrist, in his Skeleton Submissions, provided two reasons to justify LFT’s delay in commencing taxation:

(1) First, there had been on-going proceedings. It was contended that as a result of the Commissioner’s bringing of the appeal, there was thus a possibility that the appeal court would reverse the previous costs orders having been made. It would not have been, Mr Gilchrist submitted, commercially sensible for LFT to incur extra costs for commencing taxation before the ultimate costs liabilities could be finally determined[2].
(2) Second, the parties had been engaging in settlement discussions after the disposal of these proceedings in April 2012. Undisputedly, a successful settlement would have obviated any need for taxation.

17. For these two reasons, Mr Gilchrist contended that there had not been any undue delay in commencing taxation. The court, it was submitted, should not impose any sanction when the taxation proceedings have in fact been commenced within the 2-year limitation period and in full compliance with the procedures and rules.

18. If, however, LFT, were found to have unduly delayed the commencement of the taxation proceedings, Mr Gilchrist urged the court to exercise its discretion not to impose the sanction by taking into account all the relevant circumstances of the case “to achieve a just result”[3].

19. These proceedings, it was submitted, are subject to a proper consideration of the rules made under the Civil Justice Reform (“CJR”). Relevantly, the new Order 1A rule 2 requires a court to give effect to the underlying objectives as well as of a party’s conduct, such as the kind espoused by Chief Justice Ma in Wing Fai Construction Co Ltd (in liquidation) v Yip Kwong Robert[4] , a striking out application heard by the Court of Final Appeal (which is to be further discussed in §48 below).

E. Discussion – whether there is “undue” delay

E.1 Order 62 rule 22

20. Under Order 62 rule 22(1), if a party entitled to costs fails to commence taxation proceedings within 3 months after the completion date, a taxing master is empowered to:

(1) On application, compel a receiving party to expeditiously commence taxation by disallowing the commencement of taxation in the event that the taxation is not commenced within the specified time (rule 22(3)).
(2) impose a sanction for undue delay (irrespective of whether an order has been made under rule 22(3)) by: (a) making such order as he thinks fit as to the costs of any application or as to the costs of the taxation; (b) disallowing any part of the costs to be taxed pursuant to the costs order; and (c) disallowing interest or reducing the period for which interest is payable or the rate at which interest is payable in relation to the taxed costs or any part of those costs (rule 22(5)).

E.2 Any undue delay

21. Whatever way the “completion date” for taxation is to be computed, there is little dispute that LFT has not commenced taxation within the 3 months’ time as stipulated in Order 62 rule 22(1). But before the sanction provisions under rule 22(5) are to be engaged, any such delay must be “undue”, which must be inexcusable or inordinate.

E.2.1 On-going proceedings excuse

22. Whether a particular delay is excusable will depend on the facts of each case. The existence of other on-going litigation between the same parties had been held before the CJR not an excusable reason (See: The Bank of New York[5]). But post-CJR, an on-going arbitration could be a justifiable reason (See: Zebra Industries (Orogenesis Nova) Ltd[6]).

23. Neither of these cases, in my judgment, can provide much guidance to me as to what circumstances would constitute undue delay which is by and large case-sensitive. The categories of excuses hence should not be viewed in a strait- jacket.

24. In this case, the on-going proceedings essentially refer to the appeal brought by the Commissioner to the Court of Appeal with the justification having been based on the possibility of the Court of Appeal overturning the previous costs decisions, which might have the consequence of reversing the previous costs orders. In essence, whether the existence of a connected on-going proceeding would justify delaying the commencement of a taxation proceeding, in my view, depends on the facts of each case. When it is considered that there is a real likelihood that the outcome of an on-going matter in the same proceedings such as a pending appeal – subject to other considerations such as the time likely to be required for the disposal of the pending proceedings, the nature of such proceedings etc – may likely impact on the ultimate costs liabilities of the parties, it may be reasonable to withhold taxation proceedings until the conclusion of the on-going proceedings. If however, the on-going proceedings may only result in the setting-off of costs liabilities against each other, it would unlikely be a sufficient excuse for delaying the taxation proceedings.

25. In this case, the tax disputes between the parties were first remitted to the Court of First Instance in April 2010 by the commencement of HCIA proceedings, which were disposed of within a year in April 2011. Within the fairly short time frame of one year, there had been proceedings filed by the Commissioner for an application for leave to appeal against an interlocutory order, and later in May 2011, for the substantive appeal in the Court of Appeal. In such a case, the parties must have conducted the proceedings in very tight time schedules.

26. The issues involved in these proceedings also appear to have been particularly complex as reflected by the representations of both parties involving the engagements of eminent Queen’s Counsel and local counsel. Under such circumstances, LFT, in my judgment, was justified in focusing on the preparation of the appeal, which might produce an outcome of reversing the lower court’s costs orders having been made in HCIA3/2010 in its favour. In the circumstances, given the tight time schedules, the complexity of the proceedings, and the appeal by the Commissioner, I’d be inclined to accept that LFT was justified to wait until the conclusion of the appeal before commencing taxation proceedings in both actions HCIA3/2010 and HCMP541/2011.

E.2.2 Settlement negotiations excuse

27. When the time for a further appeal expired on 16 April 2012, LFT would then have been under a duty to take steps to commence taxation proceedings in respect of the costs of the three actions if costs could not be agreed.

28. LFT however sought to excuse itself for the delay based on the alleged negotiations of costs between the parties.

29. One of the underlying objectives under Order 1A rule 1(e) is to facilitate the settlement of disputes. If there had indeed been negotiations for the settlement of the costs, this would be within the spirit of the CJR, and will likely be a good excuse for withholding taxation proceedings for the purpose of saving costs and expenses.

30. Coming back to LFT’s explanation, Mr Gilchrist, whilst accepting that the documents and correspondence that he had submitted to this court do not directly allude to any negotiations on costs, he contended however that the parties’ negotiations for a global settlement were intended to have also included costs.

31. Since the only documents LFT relied on in support of the alleged negotiations for costs are the correspondence and the telephone attendance records Mr Gilchrist produced at the taxation hearing, I can only examine these documents to find out if such contention can be supported. From the documents that I have read, the only oblique reference to costs is found in the highlighted part of a sentence in the 1st draft settlement proposal entitled “Framework of Settlement Proposal” having been enclosed with the letter dated 11 September 2012 from Clifford Chance (for LFT) to the Department of Justice (for the Commissioner). The highlighted part of that sentence appears under a sub-heading described as ‘Principles’ and is in Item 2 of the draft proposal, which highlighted part reads, “An amicable settlement will no doubt save time, costs and resources of both parties and bring certainty and finality to the revenue of the Government of the HKSAR and the tax affairs of LF Group [LFT] in line with CACV 86/2011 and, where appropriate, BR39/04.”[7]

32. Despite having found a reference having been made to one of these proceedings, case no. CACV 86/2011, in the highlighted part of the said sentence, I am however unable to find or infer from it any reference to costs. All I can read from the highlighted part of that sentence is a reference to the benefit of a settlement, and that a settlement would be in line with the decision of the Court of Appeal. The other part of the said draft proposal, Item 3, all relate to tax matters or other outstanding proceedings relating to tax matters between the parties, but there was nothing on costs.

33. Having carefully read the highlighted part of the sentence in Item 2 of the draft settlement proposal and the rest of the documents, I cannot find any documents showing that there had been any negotiations on costs of these proceedings as Mr Gilchrist’s asserted.

34. For these reasons and in the absence of any evidence to support Mr Gilchrist’s contention that the settlement negotiations have or were intended to have included the costs of these proceedings, I am unable to accept LFT’s reason for the delay on the ground of the alleged negotiations for costs.

35. In my judgment, therefore, LFT should have - within the three months as from around mid-April 2012 (the expiry of the appeal period) to mid-July 2012 – actively negotiated costs with the Commissioner, and if there was no prospect of agreement, commenced taxation.

36. LFT neither negotiated costs (as I have found) nor commenced taxation in respect of the costs of these proceedings within the required period of three months in accordance with Order 62, rule 22(1).

37. I do not find the three bills of costs in these proceedings are particularly complicated though the amounts claimed are substantial. When costs could not be agreed, LFT should have without delay instructed a law costs draftsman to draw up the bills, but LFT has clearly failed to do. Had LFT done so, it could have filed the bills within the 3 months by mid-July 2012. By the time LFT commenced taxation on 15 February 2013, there had already been undue delay of 7 months. I do not accept Mr Gilchrist’s that the fact that taxation was commenced within the time limit of 2 years could amount to a good excuse.

38. Before deciding if any and what sanction is to be imposed for the proper exercise of the court’s discretion, I should however consider all the relevant factors of this case.

F. Exercise of discretion

39. One of the factors that Mr Gilchrist asked me to take into account is the Commissioner’s conduct in having failed to apply for immediate taxation, as it would have been entitled to under Order 62 rule 22(3).

40. It was contended that a party’s conduct, as having been firmly established in the striking out application in the Court of Final Appeal decision of Wing Fai Construction Co Ltd, supra, is a relevant consideration under CJR.

41. Given the complete inaction on the part of the Commissioner in taking the necessary step to counteract the delay it is now complaining of, Mr Gilchrist therefore contended that the Commissioner’s conduct is opportunistic and it should not be allowed to reap the benefit of LFT’s delay.

42. These taxation proceedings took place after the commencement of the CJR; hence the relevant CJR rules apply. Under this regime, not only is a court required under Order 1A rule 2 “to give effect to the underlying objectives” of the CJR rules when exercising any of its powers with “the primary aim in exercising the powers of the Court to secure the just resolution of disputes in accordance with the substantive rights of the parties”, the parties and their legal advisers are also required to assist the court to further the underlying objectives (Order 1A rule 3).

43. In the circumstances, I agree with Mr Gilchrist that the Commissioner’s conduct is one of the relevant factors that I should also take into account.

44. As discussed in section E.1 above, if a receiving party delays in commencing taxation within 3 months, a receiving party may face two consequences, one of which is an order of immediate taxation upon an application by a paying party under Order 62 rule 22(3) by ordering that unless the receiving party commences taxation proceedings within a specified period or the amount due is agreed between the parties, the costs order shall be wholly discharged. Such similar provision, before the CJR, was previously regarded as a protection available to a paying party[8].

45. Before CJR, similar powers of ordering taxation and sanctions for undue delay were also provided in the former Order 62 rule 22. Previously, the time allowed for commencing taxation was only one month and the sanctions a court could impose were not as so well defined as they are under the present Order 62 rule 22(5). These changes, it is believed, have been designed to – as stated in the Consultation Paper on Proposed Legislative Amendments for the Implementation of the CJR (April 2006), at p8 – meet the objective of CJR of ensuring that “a case is to be dealt with as expeditiously as is reasonably practicable and to facilitate settlement of disputes”.

46. Ensuring a case is dealt with as expeditiously as it reasonably practicable and to facilitate the settlement of disputes are two of the underlying objectives specified in Order 1A rule 1(b) and (e). Apart from the duty of the court to give effect to the underlying objectives, Order 1A rule 3 (as discussed in §42 above) imposes a duty on parties and their legal advisers to further the underlying objectives. Thus, the Commissioner and LFT would now be subject to this new duty, which, in the present case, requires them to negotiate costs to facilitate settlement and in the event that costs could not be agreed, to take reasonably practical steps in ensuring that the taxation proceedings are to be dealt with expeditiously.

47. LFT, being the receiving party, has the carriage of the action. It thus bears the ultimate responsibility of ensuring that taxation proceedings be commenced expeditiously within three months as required by Order 62 rule 22(1). In having failed to do so, LFT and/or its legal advisers have failed to give sufficient regard to the duty of furthering the underlying objectives in ensuring the expeditious disposal of the taxation proceedings.

48. Whilst LFT bears the ultimate responsibility in commencing taxation without delay, the Commissioner, as the paying party, is also required to take the necessary step to further the underlying objectives upon the LFT’s delay, which would be, in the present case, to resort to the protection accorded to a paying party under Order 62 rule 22(3) by making an application to compel LFT to commence taxation. The Commissioner’s inaction is, in my view, analogous to the conduct of the applicant (i.e. the defendant) in Wing Fai Construction Co Ltd, supra, whose conduct had been described by Ma CJ as having adopted the attitude of “letting sleeping dogs lie” by sitting “idly by and do[ing] nothing, in the hope that sufficient delay would be accumulated so that some sort of prejudice can then be asserted”[9].

49. Before the CJR, when there was then no statutory duty imposed on a party in civil proceedings to further the underlying objectives, the taxing authority had refused to deprive a paying party’s right of benefits for its inaction (See: the Bank of New York[10]), for it had been held that[11], prejudice (to the paying party) was not a prerequisite for the exercise of the court to impose sanction for undue delay for the reason that interest was to run from the date of the costs order until payment. Thus, any delay was found to have caused prejudice to the paying party[12].

50. True that it may be that due to the delay, a paying party will be required to pay more interest on the taxed costs, the receiving party’s delay however is not entirely without benefit to a paying party for the latter would have “nevertheless enjoyed an advantage in keeping hold of its money in the meantime”[13].

51. The parties (not just one party in a proceeding), as already discussed, are required by Order 1A rule 3 to assist the court to further the underlying objectives. The widened scope of Order 62 rule 22, however, has seemingly after the CJR led to a surge of objections in taxation proceedings by a paying party basing on a receiving party’s undue delay under Order 62 rule 22(5). Yet, on the other hand, there have been very few applications made under Order 62 rule 22(3) by the paying party to compel a receiving party to commence taxation. This phenomenon is, probably, due to a misguided view held by a paying party in believing that the duty imposed by Order 1A rule 3 only applies to a receiving party.

52. Such view, after the CJR, may no longer be supported. As the discussions above have shown, the obligations under Order 1A rule 3 apply to parties, not just one party, to the proceedings. If therefore, when a paying party, in appropriate cases, has chosen to lie idly by without an explanation, and later take advantage of the accumulated delay of the receiving party in commencing taxation proceedings, a taxing authority may take into account of such conduct in the exercise of a court’s discretion under Order 62 rule 22(5).

53. In this case, apart from relying on the period of LFT’s delay, the Commissioner has neither written to LFT to discuss the costs nor resorted to the protection having been accorded to it against the latter’s delay under Order 62 rule 22(3). In my judgment, the Commissioner’s lack of explanation for its inaction makes it just for me to also take into account its conduct.

54. Next, I should also take into account the length of undue delay, which according to my finding, has been a relatively short period of 7 months. If sanction were to be imposed, I must however, for the following reasons, reject the global percentage deduction the LCD advocated in this case.

(1) First, the delays ranging from 8 months[14] to 5 years[15] in the cases referred to by the LCD were much more serious than the present proceedings.
(2) Secondly, all of the said cases but one[16] was pre-CJR decisions. Prior to the CJR, there was no time limit for commencing taxation. The new Order 62 rule 22(7) now imposes a time limit of 2 years for the commencement of taxation. As a consequence of the new time limit, excessive delays longer than 2 years will unlikely occur, and the sanctions of global deductions previously imposed by the court may not be an applicable guide.
(3) Thirdly, before the CJR, the type of sanction a taxing master was empowered to impose for undue delay under the old Order 62 rule 22(3) was much narrower in scope, which only provided the taxing authority to disallow any item contained in a bill of costs. Reducing a specified percentage of taxed costs – as shown by the cases mentioned in § 13 above – had been commonly adopted by taxing masters under the old Order 62 rule 22(3). The global deduction approach, when considered in the light of the widened scope of the sanction powers now available in the new Order 62 rule 22(5), may, in some cases, appear rather arbitrary, or even unjust.

55. The sanctions now available are much wider in range, which include not only a disallowance of the taxed costs, but also a deduction of a period of interest on the costs to be taxed.

56. Having considered all the relevant factors discussed above, I should, in order to mark the court’s disapproval of LFT’s undue delay, exercise the discretion to impose sanction. However, the proper sanction to be imposed, in my judgment, should also appropriately reflect the Commissioner’s similar disregard of its duty to assist the court in furthering the underlying objectives of the CJR as already discussed above.

57. For the foregoing reasons I do not consider it appropriate to sanction LFT by a global deduction of the costs to be taxed. In my judgment, given the Commissioner’s conduct, I should exercise my discretion to deprive LFT of its interest on such costs for only a period of 5 months rather than the full period of undue delay of 7 months in order to achieve a just result.

58. In conclusion, I shall disallow interest on the costs to be taxed in each of the three bills for 5 months from around mid-July 2012, say 15 July 2012, to around mid-December 2012, and say 15 December 2012.

Order and directions

59. In respect of the Commissioner’s preliminary objection, it is ordered that there shall be no interest from 15 July 2012 to 15 December 2012 on the costs to be taxed in each of the three bills of costs filed in these proceedings.

60. As for the costs of this objection, I will hear submissions at the resumed taxation hearing that has been adjourned part-heard. Since some of the remaining items to be taxed concern arguments on whether the costs claimed by LFT in respect of the costs having been incurred for the application for the admission of overseas counsel are recoverable , I direct counsel from the Department of Justice should attend the adjourned hearing in respect of this objection as I have noted in this objection that the LCD, though highly experienced, has not been able to render sufficient assistance to me concerning some of the submissions Mr Gilchrist made. Thus, in the future, it would be highly preferable - and indeed necessary in some cases – for solicitors to attend a taxation hearing whenever an objection, such as the present one, involves substantial legal submissions.

	(Katina Levy)
	Master of the High Court

Mr H Wu, LCD & Mr Brian Gilchrist, of Clifford Chance, for the respondent

Mr O Lee, LCD & Ms M Tong, costs clerk of Department of Justice, for the appellant

[1] (1) Attorney General v Commodore Electronics Ltd. [1994] 1 HKC 660;

(2) Lim Ho Kwan v Urban Council, unrep., HCMP 1662 of 1988;

(3) The Bank of New York v Adrienne Marsh Lefkowitz, unrep., Civil Appeal Nos.190 of 1993 and 33 of 1995;

(4) Review of Taxation, unrep., HCA 6086 of 1994 et al.;

(5) Dollarwell Investments Ltd v Donald Koo Hoi Yan, unrep., HCA 12307 of 1995;

(6) PBM (Hong Kong)Limited v Tang Kam Lun, Allan & ors., unrep., HCA 12138 of 1997 & HCA 13316 of 1997 ; and

(7) Zebra Industries (Orogenesis Nova) Ltd. v Wah Tong Paper Products Group Limited, unrep., HCA 1551 of 2004 & HCMP 2044 of 2008.

[2] Zebra Industries (Orogenesis Nova) Ltd. v Wah Tong Paper Products Group Limited, unrep., HCA 1551 of 2004 & HCMP 2044 of 2008.

[3] Wing Ming Garment Factory Ltd v Incorporated Owners of Wing Ming Industrial Centre& Others, Unrep., HCA8805/1993 & CACV27/2008, Recorder Jat SC ([2012] 1 HKC 290)

[4] [2012]1HKLRD 589.

[5] The Bank of New York v Adrienne Marsh Lefkowitz, unrep., Civil Appeal Nos.190 of 1993 and 33 of 1995 at p.4.

[6]Zebra Industries (Orogenesis Nova) Ltd. v Wah Tong Paper Products Group Limited, unrep., HCA 1551 of 2004 & HCMP 2044 of 2008

[7] BR39/04 relates to the proceedings before the Board of Review which decision became the subject proceedings of HCIA3/2010 and CACV86/2011.

[8] The Bank of New York v Adrienne Marsh Lefkowitz, unrep., Civil Appeal Nos.190 of 1993 and 33 of 1995 at p.5.

[9] Wing Fai Construction Co Ltd (in liquidation), supra. per Ma CJ at §75(8).

[10] The Bank of New York v Adrienne Marsh Lefkowitz, unrep., Civil Appeal Nos.190 of 1993 and 33 of 1995.

[11] Lim Ho Kwan v Urban Council, unrep., HCMP 1662 of 1988.

[12]Ibid. at §23.

[13]Attorney General v Commodore Electronics Ltd. [1994] 1 HKC 660 at 663D, per Master Gould.

[14]Review of Taxation, unrep., HCA 6086 of 1994 et al.

[15]Lim Ho Kwan v Urban Council, unrep., HCMP 1662 of 1988.

[16]Zebra Industries (Orogenesis Nova) Ltd. v Wah Tong Paper Products Group Limited, unrep., HCA 1551 of 2004 & HCMP 2044 of 2008

CACV 86/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 86 OF 2011

(ON APPEAL FROM HCIA NO. 3 OF 2010)

____________________________

BETWEEN

	COMMISSIONER OF INLAND REVENUE	Appellant
	and
	LI & FUNG (TRADING) LIMITED	Respondent

____________________________

Before: Hon Tang VP, Hartmann JA and Chu JA in Court

Dates of Hearing: 14 and 15 February 2012

Date of Judgment: 19 March 2012

________________

JUDGMENT

________________

Hon Tang VP:

Introduction

1. The taxpayer, Li & Fung (Trading) Ltd ("LFT") is incorporated in Hong Kong and wholly owned by LFBVI (a BVI company).

2. By a determination dated 14 June 2004 ("the Determination"), the Commissioner of Inland Revenue ("the Commissioner") required LFT to pay additional profits tax or profits tax amounting to about $110 million for the years of assessment, 1992 to 2002.

3. LFT objected to the assessments on the basis that the relevant profits were offshore in nature and not chargeable to profits tax.

4. It is common ground that LFT's business included services which it provided to its customers who are importers, department stores, chain stores and specialty shop located overseas ("the customers") for which, typically, LFT was paid 6%[1] of the FOB value of the goods supplied to such customers. The assessments relate to profits thus derived.

5. A standard contract with the customers under which such services would be provided ("the standard agency agreement"), contained the following terms:

"1   The Agent (LFT) is hereby appointed non exclusive buying agent of the principal for the purchase of merchandise on the terms and conditions herein contained from Hong Kong, Macau, Peoples Republic of China, Taiwan, Korea, Philippines, Thailand ...
2.   a)    The purchase price for the merchandise shall be FOB the country of origin unless otherwise agreed by the Principal.
……
c)   Unless otherwise specifically arranged between the parties payment for all purchase of merchandise by the Principal shall be by transferable, irrevocable Bankers' Documentary Credit to be established in favour of the Agent …
3.   The services performed by the Agent are as follows :-
a)   Locate Suppliers, arrange manufacture, place orders in the Territory on the behalf of the Principal under the Principal's standard terms & conditions of trading. The Agent shall have no authority to place an order for goods without having first received prior written authorisation from the Principal.
b)   Keep close contact with the Suppliers to ensure that production is running according to the delivery schedule set by the Principal for each item.
c)   Maintain quality control on merchandise including inspection on a random basis to ensure that items being produced conform to the Principal's requirements.
d)   Arrange for the shipment of the Merchandise under instruction of the Principal, including assisting the Supplier where necessary with the preparation of all relevant export documentation.
e)   Attempt to settle possible merchandise claims on behalf of the principal.
f)   Endeavour to keep Principal advised from time to time of new developments in markets of the Territory which may be of interest to the Principal.
g)   Sign or countersign contracts/purchase orders/commitment on Principals behalf.
For such services as described in a) to g) above the Principal will pay the Agent a commission of 6% (six percent) on the FOB value of the merchandise at the time of payment as stated in point 2c."

6. LFT in turn entered into contracts with local companies ("the standard affiliates contract"), typically its affiliates, under which the local companies would provide services to LFT in return for 4%[2] the FOB value on these terms:

"(a) to research and locate suppliers for products and goods which the Company may require from time to time and generally to coordinate the supply of and demand for products provided by the Company between suppliers and customers and to advise the Company in respect of sourcing of products;
(b) to furnish continuous information concerning products availability, market conditions, and, in particular, information concerning the Company's suppliers and advise on matters of pricing;
(c) to arrange and obtain samples of products from suppliers and to assist the Company's suppliers with any problems relating to the exportation or application for export license of goods;
(d) to assist and advise on methods of transporting, storing and delivery of goods from the Company's suppliers and to provide advice regarding packaging systems and materials most suitable for goods;
(e) to assist the Company in investigating and settling any claims and complaints against products or goods supplied;
(f) to arrange for the packaging and shipping of the goods or products as shall be purchased by the Company and/or its customers and to act on and in accordance with the instructions of the Company in connection with such matters;
(g) to provide inspectors to monitor quality control of products offered by the Company whenever such quality control services are required by the Company in Thailand;
(h) to do such other acts and things as the Company and LFTL shall from time to time mutually agree."

7. There was also an agreement made between LFT and LFBVI under which LFBVI agreed to provide, for example, "promotional and marketing services outside of Hong Kong" for which LFT agreed to pay LFBVI "a fee calculated at 2% of the FOB value of all export sales made by the Company".

8. The agreement to pay this fee to LFBVI was also the subject of the Determination. There, the Commissioner concluded that the payment of such fees to LFBVI was part of a transaction under section 61A of the Inland Revenue Ordinance (Cap 112) ("IRO") entered into or carried out for the sole or dominant purpose of obtaining tax benefits.

9. On the taxpayer's appeal to the Board of Review ("the Board"), the Board held in favour of the taxpayer in respect of the source of income point and against the taxpayer on section 61A[3].

10. On 19 March 2010, the Board stated the following questions of law for the opinion of the Court of First Instance:

"(1) Whether, on the facts found by the Board, the true and only reasonable conclusion contradicts the Board's conclusion at paragraph 86 and paragraph 95 of the Decision, namely all of LFT's disputed profits were sourced outside Hong Kong and no apportionment would arise?
(2) Whether, on the facts as found by the Board, the Board's conclusion (at paragraph 144 of the Decision) that LFT and LFBVI entered into or carried out the transaction as identified by the Board in paragraph 99 of the Decision for the dominant purpose of enabling LFT to obtain a tax benefit is contrary to the true and only reasonable conclusion?"

11. By agreement of the parties, the 2^nd question has been deferred pending remittal of certain matters to the Board.

12. Reyes J answered the first question in favour of LFT and this is the Commissioner's appeal.

The law

13. The legal principles are not disputed and can be stated briefly. On the question where the profits was sourced,

"one looks to see what the taxpayer has done to earn the profit in question and where he has done it." CIR vHK-TVB International Ltd (P.C.) [1992] 2 AC 397 at 407C.

14. As Bokhary PJ said, with the agreement of the other members of the court, in Kwong Mile Services Ltd v CIR (2004) 7 HKCFAR 275 at 283G:

"… The situations in which the source of a profit has to be ascertained are too many and varied … the only constant is the need to grasp the reality of each case, focusing on effective causes without being distracted by antecedent or incidental matters."

15. Ribeiro PJ make it clear in ING Baring Securities (Hong Kong) Ltd v CIR (2007) 10 HKCFAR 417 that one should not:

"53. … investigate every facet of the Taxpayer’s business so that it could engage in a qualitative assessment of the relative importance of its various operations, choosing 'the more important things done' towards the generation of those profits as the criteria for determining geographical source. … (that) places an erroneous emphasis on matters properly regarded as antecedent or incidental to the profit-generating operations."

otherwise, one

"50. … emphasises antecedent or incidental matters that, while commercially essential, are legally irrelevant. …"

Reyes J's Judgment

16. Reyes J noted that the LFT's case before the Board was that it engaged or acted through its local affiliates

"9. … in performing the services which LFT has contracted to provide to its customers.
……
14. In contrast, the Commissioner argued before the Board that LFT’s profit was the difference between the 6% which it received from its customers and the 4% which it paid to its affiliates. The Commissioner suggested that LFT operated a 'supply-chain management business'. In consequence, whereas LFT’s affiliates earned their 4% for activities abroad, LFT (the Commissioner reasoned) earned 2% for managing its own activities and those of its affiliates from LFT’s Hong Kong headquarters.

17. And that the Commissioner's case was rejected by the Board who:

"16. … held that LFT was 'a commission agent'. LFT’s business was 'that of undertaking, on behalf of its own customers, the sourcing of merchandise for its customers'. In short, LFT 'sold services for commission'."

18. Reyes J went on to note the relevant findings of the Board and that the Board in coming to its conclusion had followed the decision of the Court of Final Appeal in ING Baring.

19. Reyes J then turned to consider what he described as the Commissioner's reformulated case in the appeal[4] saying that the Commissioner no longer pressed the submission that LFT was carrying on a "supply-chain management business". Instead, Mr Benjamin Yu, SC (who, with Mr Eugene Fung, appeared for the Commissioner below as well as before us) argued that the Board had erred in not apportioning the gross profit of 6% which LFT received from its customers, which Mr Yu submitted:

"33. … was earned as a result of activities carried out both in Hong Kong and abroad. Insofar as non-Hong Kong based affiliates were involved, Mr. Yu accepted that some of LFT’s profit had an overseas source. On the other hand, insofar as LFT managed and supervised its affiliates from Hong Kong, part of LFT’s profits (Mr. Yu argued) must have had a Hong Kong source."

20. Also Mr Yu complained that the Board had failed:

"35. … to consider each of the activities (a)-(h)[5] set out in the standard agency agreements between LFT and its customers. Had the Board done its job properly, it would have appreciated that, as a matter of fact, activities (a)-(d) required certain matters to be done or resources to be maintained in Hong Kong to enable a 6% commission to be successfully earned."

21. Reyes J then went on to deal with each of the relevant activities[6] and concluded that insofar as LFT maintained back-up or support services for its affiliates at its Hong Kong headquarters, the Board was entitled to disregard them as antecedent activities which although:

"42. … commercially essential to the operations and profitability of [LFT's] business … do not provide the legal test for ascertaining the geographical source of profits.".

22. In relation to Mr Yu's complaint that the Board had failed to analyse what specific operations were involved in carrying out activities (a) to (e), and in its duty to make findings as to which specific operations within those activities (a) to (e) took place in Hong Kong and which did not, Reyes J was of the view that if the Board had embarked on such an investigation that would have been to engage in what was described in ING Baring as a "legally irrelevant" exercise. The learned judge also compared Mr Yu's argument with the

"50. … 'brain analogy' which the CFA criticised in ING Baring …"

and said:

"51. … To my mind, Mr. Yu is saying no more than that at the material times LFT’s senior administrative staff based in Hong Kong oversaw the activities of various overseas affiliates within the Li & Fung group. That fact alone (the CFA has said in ING Baring … ) is not an appropriate criterion for ascertaining the geographical location of a profit."

23. Reyes J then concluded that:

"55. … the Board’s findings and conclusions on the source of LFT’s profits are unassailable. There is no basis for saying that the Board ought to have apportioned the 6% commission in the way Mr. Yu suggests. Nor can it be said that the Board acted irrationally or that its conclusions were unsupported by the available evidence."

24. With respect, I agree with Reyes J. His conclusion is amply justified by the Decision, and supported in particular by the following paragraphs in the Decision:

"Board's decision on source of profits
75.    Mr Goldberg told us we were only concerned with the third factor in Hang Seng, i.e. whether the profits were 'profits arising in or derived from' Hong Kong.
76.    On the question whether LFT was a commission agent or a buyer and seller of goods, Mr Milne did not seem keen to argue that LFT was not a commission agent. With respect, he was clearly correct. We are satisfied by the agreements made by LFT with its customers, the placement memoranda, the placement reports and the oral evidence of John Arthur Heaviside, Phanprapaivadee Suchato, Danial Christian Deyoe, Mohammad Tofazzal Ali, Duangtida Ingsatht and Vajara Tanthanathip that LFT was a commission agent. We find as a fact that appellant's business was that of undertaking, on behalf of its own customers, the sourcing of merchandise for its customers. In other words, its sold services for a commission.
77.    However, Mr Milne did argue that the local LF sourcing companies were sub-contractors of LFT, not its agents.
78.    Based on the sample documentation, and in particular, the agreements made between LFT and the local LF sourcing companies, we find as a fact that the local sourcing companies were LFT's agents.
79.    In any event, whether the local LF sourcing companies were LFT's agents or sub-contractors does not affect the correct resolution of the issue of the geographical location of LFT' s profit producing transactions. It is not in dispute that LFT employed the local LF sourcing companies to act for LFT in carrying out transactions for customers. Thus, LFT's profits were earned in the place where the local LF sourcing companies carried out LFT's instructions, whether they did so as agents or principal, see ING Baring Securities, per Lord Millett at paragraph 147. For this reason, we are unable to accept Mr Milne's submission we should not be looking at the local LF sourcing companies' activities.
80.    Mr Milne also argued that we are not concerned with gross receipts, but with gross profits. Assuming that it was open to Mr Milne to so argue and also assuming that he was correct, LFT contracted to render a service to its customers, and its net commission, after paying the local LF sourcing companies 4%, arose in the place where it rendered it, i.e. offshore, see ING Baring Securities, per Lord Millett at paragraph 145, where his Lordship said (emphasis added):-
'In Mehta the taxpayer's profits in those cases where he acted for clients consisted of the net commission representing the difference between the commission he paid to the brokers who carried out the transactions (which was an expense) and the larger commission he charged to his own clients. His right to retain the net commission was a contractual right which arose under the contract with his client. But the geographical source where his profit arose was not the place where the contract was entered into (which was Bombay) but the place where it was performed. He contracted to render a service, and the net commission arose in the place where he rendered it: see the passage previously cited in the opinion of Lord Bridge in Hang Seng Bank.'
81.    Further, in view of our finding that the local LF sourcing companies were LFT's agents, the issue cannot arise.
82.    Mr Goldberg also pointed out that LFT's accounting treatment was reproduced in the Determination without challenge and that it was not open to CIR to do so in her final submission. He went on to submit that when a trader bought and sold an asset, a gross profit was established by deducting the cost of the asset from its sale proceeds to arrive at the gross profit. However, in a service industry there was no asset cost to deduct above the line and there were and could only be the costs of earning receipts which were all overheads and below the line deductions. We accept Mr Goldberg's submission.
83.    The focus is on establishing the geographical location of LFT's profit-producing transactions themselves as distinct from activities antecedent or incidental to those transactions.
84.    Clause 3 of the sample agreement made with Mackeys referred to in paragraph 54 above provided that Mackeys would pay LFT 'a commission of 6% (six percent) on the FOB value of the merchandise'. LFT contracted to provide services. The profit producing activities or services started from the placement of orders by LFT's customers with suppliers, continued throughout the whole process of the production of the merchandise until the successful conclusion of the orders by shipments of the merchandise to the customers and in some cases continued further until the conclusion of follow-up services. It was through those transactions or activities that LFT earned its commissions and charges which were payable only after the completion of the shipment of the merchandise. LFT employed the local LF sourcing companies to act for LFT in carrying out these profit producing activities or services. It mattered not whether the local LF sourcing companies were LFT's agents or sub-contractors. We find as a fact that all the profit producing/making activities/transactions took place outside Hong Kong. We further find that the geographical source of LFT's net commission representing the difference between the commission it paid to the local LF sourcing companies which performed the sourcing services and the larger commission which it charged to its own customers arose outside Hong Kong.
85.    As LFT contracted to provide services, our finding in paragraph 84 above is in line with the guiding principles, see Hang Seng at pp. 322 - 323 and ING Baring Securities, per Lord Millett at paragraph 147.
86.    We conclude with our finding that the disputed profits were all sourced outside Hong Kong. Thus, no question of apportionment arises. We should add that neither Mr Goldberg nor Mr Milne was really interested in apportionment."

This Appeal

25. Mr Yu confirmed that the essence[7] of the Commissioner's case is stated in para 38 of his skeleton argument which reads:

"38. … since the services performed by LFT in Hong Kong were part of the profits-producing transactions (because they were expressly agreed to be so under the LFT/Customer Contracts), the matters which the CIR relies upon cannot be described as antecedent or incidental matters."

26. He relied on the fact that the standard agency agreement provided that for the activities set out in clause 3, LFT would be paid a commission. He submitted that some of such activities took place in Hong Kong and any profit attributable to them are therefore taxable.

27. It is not surprising that Mr David Goldberg, QC, who appeared for LFT with Mr Stewart Wong SC, commenced his submissions by remarking on the protean nature of Mr Yu's advocacy. The para 38 argument is a refined version of the reformulated argument.

28. We have a copy of Mr Yu's skeleton submission dated 31 March 2011 prepared for the hearing before Reyes J. Mr Yu has confirmed that this point which is central to its appeal was not raised in the written skeleton. The reformulated argument was raised for the first time orally before Reyes J on 6 April 2011. Nor had counsel (who then appeared for the Commissioner)[8] taken either point before the Board.

29. Mr Yu submitted the Board ought to have asked itself whether any of the activities under clause 3 was performed in Hong Kong, and if so, how much. The Board should go on to decide that tax would be payable on the profits attributable to the services performed in Hong Kong, and apportion such profits accordingly[9].

30. Mr Yu submitted that insofar as the Board has failed to do so, we should remit the matter to them for further consideration. Although Mr Yu pointed to the fact that in ING Baring the Court of Final Appeal felt able to determine factual issues itself, he accepted that this is not such a case since we are not in a position to make the factual findings which are essential to the para 38 argument.

31. This is not a case for remitter. We are dealing with the years of assessment 1992 to 2002 and the Determination was made 8 years ago and like Ribeiro PJ, I also "recoil from the idea of a remitter"[10]. More importantly, the Commissioner has not made out a case for remitter.

32. The main contest between the parties before the Board was over the characterization of the taxpayer's business. Then, it was the Commissioner's case that the activities of the local affiliates should be disregarded, because their activities were not part of the taxpayer's business, and did not generate any relevant profit.[11]

33. In fairness to counsel who appeared for the Commissioner before the Board, it is easy to understand why the Commissioner had not taken the para 38 argument (nor the reformulated argument) before the Board. When one compares the services to be provided under the standard agency agreement and the services which LFT's affiliates had undertaken to provide under the standard affiliates contract, it is obvious that they covered essentially the same matters. Given the injunction "to grasp the reality … focusing on effective causes …"[12], had either argument been raised before the Board, I believe the Board would have expressly decided it against the Commissioner.

34. The Commissioner's case before the Board was that LFT had agreed with a customer to perform certain operations for 6%, and is paying a 3^rd party 4% (the overseas affiliates, eg Li & Fung (Korea) Ltd) to perform the overseas part of those operations. What was left to LFT, namely, 2%, related entirely to its trade of "supply-chain management" which it carried on through its senior "controlling minds" in Hong Kong. That profit was earned not through day to day handling of orders from customers (that had been sub-contracted to the affiliate companies) but through maintaining long-term commercial relationships and monitoring the performance of the contracts the LFT had with its customers.

35. Mr Yu also relied on the fact that apportionment was an issue before the Board, but it is clear that there apportionment was sought on a different basis, as can be seen from the skeleton argument dated 13 January 2006 for the Commissioner:

"10. Even if the overseas affiliates were acting as agents of the Appellant, and so were sub-agents of the customers, the Commissioner would still submit that for profits tax purposes, the operations of the overseas affiliates should be viewed separately from the operations of the Appellant. The overseas affiliate gets its share (4%) of the gross commission (7%) for its work overseas: what is left to the Appellant as profit relates entirely to what the Appellant itself does.
……
29. Should the Board consider that apportionment is in point, the Commissioner submits that determining the appropriate apportionment is very simple, in that the Appellant has already done it for us. It has apportioned its profits between the onshore part of its operations and the offshore part of its operations by engaging the overseas affiliates to perform the offshore part for a commission (originally 4% of FOB, then 5% of costs). It has never been suggested by the Appellant that this is not a proper price for the overseas affiliates to pay; all that Edward Yim said (Day 8, pp 12 and 13) was that the original 4% arrangement sometimes caused cash flow problems for the affiliates, so they were changed to 'cost plus 5%', but the two calculations worked out 'more or less the same': see Edward Yim's answer to the Chairman's question, Day 8, p 33. Mr Yim confirmed that the overseas affiliates paid tax on its profits calculated only by reference to the commission received from the Appellant. The Commissioner submits that there is no need for any further apportionment."

36. Had the para 38 argument been run before the Board, it might have undermined the Commissioner's then more ambitious claim, which was for 2%[13] of the FOB value.

37. For completeness' sake, I turn to the skeleton submission for the Taxpayer dated 28 December 2005, prepared for the hearing before the Board, there a relevant issue was identified as:

"9. iii) where do LFT's profits arise? Do they (as the IRD contends) arise wholly in Hong Kong or (as the tax payer submits) in Hong Kong (where the local office handling the order is in Hong Kong) and outside Hong Kong (where the local office handling the order is outside Hong Kong)?"

38. The Taxpayer's skeleton submission went on to say:

"80.(1) The taxpayer does not accept that any services which produce profits are performed in Hong Kong where an order is being handled by a local office outside Hong Kong; and it asserts that, in such a case, all the relevant services are performed outside Hong Kong and that whatever (if anything) is done in Hong Kong is preparatory, antecedent, incidental or ancillary to the earning, and not an effective cause, of the profits."

39. There were also in paras 10 - 65 submissions on the facts to support the taxpayer's case, which underlined the important distinction between LFT managing its business in Hong Kong and its source of profits by its affiliates outside Hong Kong. The Taxpayer's case compares well with this description of ING Baring's activities by Ribeiro PJ:

"50. Such an approach fails to focus on the transactions which proximately produce the profits and emphasises antecedent or incidental matters that, while commercially essential, are legally irrelevant. However impressive the client may find the Taxpayer’s research and sales service, in the absence of trades successfully executed abroad, no brokerage income arises. But quite apart from that objection in principle, the Board’s suggestion is at odds with the evidence. Thus, the evidence was that '... approximately two thirds of the Asian Agency Brokerage business of the Group was generated by sales effort in the London and New York offices.' Moreover, the Board found that the research 'was undertaken by analysts based in each market' with the research publications then being 'distributed to clients and ... used primarily by sales desks as reference and selling material stock.' If two-thirds of the Group’s Asian agency business was generated by sales activities in London and New York using research generated by analysts working in the foreign markets in which the trades were effected, it is very hard to see how focusing on these as 'factors' could lead to the conclusion that profits generated by those activities were sourced in Hong Kong."

40. I have gone into some detail over the way in which the matter was argued before the Board because I believe Mr Yu's complaint that the Board had failed to deal with the para 38 argument is unfair. The Board could not be blamed for not dealing with a point which was not raised before them.

41. In his submission before us, Mr Yu focused on paras 84 – 86 of the decision, and submitted that they were conclusionary findings of the Board and that they had given no reasons. He also complained that although the hearing had concluded on 19 January 2006, the decision was not handed down until 12 June 2009, a regrettable fact which the learned judge has remarked upon in his judgment.

42. Given such delay, obviously we should scrutinize the Board's findings of fact and the reasons for their conclusions with particular care in order to see whether the decision contained errors probably or possibly, attributable to the delay sufficient to satisfy us that it would be unsafe and unfair to allow it to stand: Cobham v Frett [2001] 1 WLR 1775.

43. However, as Mr Goldberg has explained, the Board had had the benefit of the transcript of the proceedings and carefully prepared submissions with cross-references to the transcript. The factual evidence consisted of oral testimony (LFT called 34 witnesses) as well as written statements. Their evidence have been summarized with great care in pages 37-62 of the decision, followed by a careful consideration of the expert evidence which occupied pages 62-76 with citations from the transcript of their evidence.

44. Mr Yu commented on the fact that the Board had summarized the evidence of the factual witnesses without stating which part of their evidence it had accepted. But it is obvious that the bulk of such evidence (relating to the source of income issue) was uncontentious. Indeed, para 29 of the Decision states:

"Mr. Milne told us that 'there should not be too much scope for disagreement about the primary facts' and that CIR was not so concerned about what happened at the bottom but was more concerned about what happened at the top."[14]

45. But when the Board dealt with evidence which was potentially controversial, such as the expert evidence, it dealt with such evidence critically. There is no substance in the complaint that the Board had merely summarized the evidence of the factual witnesses. Nor do I agree that the Board has not given sufficient reasons.

46. The Decision also contained a careful consideration of the authorities on "source of profits" (pages 94 to 102). The learned chairman traced the authorities from CIR v Hang Seng Bank Ltd [1991] 1 AC 306 to ING Baring, the judgment of which was delivered about 1½ year after the conclusion of the hearing before the Board. Mr Yu complained that although the Board had referred to and relied on ING Baring, the parties were not given an opportunity to address the Board on that decision. ING Baring provided important elucidation on the application of settled principles, and which the Board would have been remiss to ignore. The Commissioner, if he thought it advisable to do so, could have requested an opportunity to address the Board on ING Baring. Furthermore, I do not understand Mr Yu to say that the Board had misunderstood ING Baring[15].

47. Mr Goldberg emphasised that the question before us is:

"Whether, on the facts found by the Board, the true and only reasonable conclusion contradicts the Board’s conclusion …"

48. Mr Goldberg submitted and I agree:

"1.2 The Board, in the Decision, considered the arguments of the Respondent, the CIR, applied the correct principles and, on the basis of the Evidence before it, made the Fundamental Finding:
'… as a fact that all the profit producing/making activities/transactions took place outside Hong Kong'.
By the Conclusion, the Board held:
'that the disputed profits were all sourced outside Hong Kong. Thus, no question of apportionment arises.'"

49. Mr Goldberg also submitted that in para 84, the Board made findings of facts and they found that where orders were handled by an agent, everything which, factually LFT did and had to do to earn profits, was done outside Hong Kong. I agree.

50. It is perhaps revealing that Mr Yu commenced his submission by referring us to the decision of Barnett J in Commissioner of Inland Revenue v Inland Revenue Board of Review and Anor [1989] 2 HKLR 40 where Barnett J said at page 47:

"… that once the Court is seized of a case stated, it must, subject to any necessary adjournment, deal with any point of law arising out of the case stated."

51. Mr Yu also relies on the judgment of Yuen J (as she then was) in Commissioner of Inland Revenue v Quitsubdue Ltd [1999] 2 HKLRD 481 at 485, where she said the court might:

"… determine a question of law which it considered arose from the Case Stated, even if it were not contained in it."

52. With respect, I do not believe these observations assist Mr Yu. I have stated earlier that the Board could not be faulted for not dealing with the para 38 argument, which was not raised before it. I can see no basis to remit the matter to the Board so that the Commissioner could then advance a new case on apportionment.

53. Mr Yu submitted that although the question asked:

"Whether, on the facts found by the Board …" (my emphasis),

further facts have been agreed, 2 of which he submitted, are important. These facts are:

"6. In an interview reported in the Harvard Business Review dated 1 September 1998, Mr Victor Fung said:
'The company is managed on a day-to-day basis by the product group managers. Along with the top management, they form what we call the policy committee, which consists of about 30 people. We meet once every five to six weeks. People fly in from around the region to discuss and agree on policies. Consider, for example, the topic of compliance, or ethical sourcing. Compliance is a very hot topic today - as well it should be. Because our inspectors are in and out of the factories all the time, we probably have a better window on the problem than most companies. If we find factories that don't comply, we won't work with them. However, because there is so much subcontracting, you can't assume that everyone is doing the right thing. That is, you have to make sure that a supplier that was operating properly last month is still doing so this month. The committee of 30 not only shapes our policies but also translates them into operating procedures we think will be effective in the field. And then they become a vehicle for implementing what we've agreed on when they return to their divisions.'
……
9. In an interview reported in the Harvard Business Review dated 1 September 1998, Mr Victor Fung said:
'Consider our Gymboree division, one of our largest. The division manager, Ada Liu, and her headquarters team have their own separate office space within the Li & Fung building in Hong Kong. When you walk through their door, every one of the 40 or so people you see is focused solely on meeting Gymboree's needs. On every desk is a computer with direct software links to Gymboree. The staff is organized into specialized teams in such areas as technical support, merchandising, raw material purchasing, quality assurance, and shipping. And Ada has dedicated sourcing teams in our branch offices in China, the Philippines, and Indonesia because Gymboree buys in volume from all those countries. In maybe 5 of our 26 countries, she has her own team, people she hired herself. When she wants to sources from, say, India, the branch office helps her get the job done.'"

54. To put Mr Yu's submission in context, it is necessary to go back in time. The case stated is dated 19 March 2010, and the hearing of the appeal was fixed to commence before Reyes J on 6 April 2011 with four days reserved.

55. By summons stated 15 July 2010, the Commissioner applied, under section 69(4) of the Inland Revenue Ordinance, Cap. 112, to have

"1.   the case stated remitted to the Board;
2.   by way of amendment or edition to the case stated the Board do:
(1)   set out the evidence in Part I of the Schedule;
(2)   pose the additional questions set out in Part II of the Schedules;"

56. On 11 February 2011, by summons of that date, the Commissioner asked for leave to amend the summons of 15 July 2010. The amendment asked that the Board:

"3. make findings of primary facts relating to the issues raised by the additional questions set out in the Part II of the Schedule."

57. Part II of the Schedule raised four questions. The 1^st and 2^nd questions related to source of income. The summons of 11 February 2011 sought to amend in part – the first of these two questions. I will not go into the new questions which were sought to be raised, suffice to note that these questions did not include the reformulated argument or the para 36 argument, and it does not appear that the summons of 11 February 2011 and what followed were made in aid of the reformulated argument or para 36 argument.

58. At the hearing on 17 February 2011, Reyes J gave leave to amend the summons but he struck out the 1^st and 2^nd questions. The learned judge also suggested that the parties should try to come up with a list of agreed facts, so that it would not be necessary to ask the Board to make additional findings.

59. By 15 March 2011, the parties had agreed a total of 12 facts[16]. However, some facts which the Commissioner wished to be agreed were not agreed. As a result, the Commissioner restored the summons for hearing before Reyes J on 28 March 2011. The Commissioner then sought a remittal to the Board for a finding of fact that:

"The contents quoted in paras. 6 and 9 of the agreed facts of what Victor Fung said to the Harvard Business Review are facts."

60. On 28 March 2011, Reyes J dismissed the amended summary. According to the transcript, the learned judge said:

"COURT: Fine. I think it is far too late for me to remit anything back to the Board. It was incumbent on the Commissioner to get her act together at a much earlier stage if there were going to be any facts to be – or any questions of fact to be remitted to the Board to make further findings.
It seems to me that this is very last minute, and I simply cannot allow it at this stage, and therefore the application is dismissed."

61. There was then an application for leave to appeal against Reyes J's decision of 28 March 2011 which was heard by this court (Tang Ag CJHC and A Cheung J (as he then was)) on 1 April 2011. The court refused leave to appeal[17].

62. I mention these proceedings to underline the fact that paras 6 and 9 of the agreed facts cannot help the Commissioner since although what Mr Victor Fung was reported to have said in Harvard Business Review was agreed, the contents were not agreed.

63. Furthermore, Mr Yu's reliance on the Harvard Business Review reports was to show that some of the clause 3 activities were performed in Hong Kong. But since the point had not been taken before the Board it would not be right to remit the matter to the Board to enable the Commissioner to raise this new point which most probably will require further evidence.

64. For the above reasons, I dismiss the Commissioner's appeal with an order nisi that the Commissioner pays the costs of the appeal.

Hon Hartmann JA:

65. I agree fully with the judgment of the Vice President.

Hon Chu JA:

66. I agree with the reasons given by the Vice President and the orders that he proposes.

(Robert Tang)
Vice-President

(M J Hartmann)
Justice of Appeal

(Carlye Chu)
Justice of Appeal

Mr. Benjamin Yu, SC and Mr. Eugene Fung instructed by Department of Justice for the Commissioner of Inland Revenue

Mr. David Goldberg, QC and Mr. Stewart K. M. Wong, SC instructed by Clifford Chance for the Respondent

[1] On appeal to Reyes J and us, the parties have proceeded on the basis that LFT was paid 6%. That was not invariably the case, it could be higher (7% was the figure used before the Board).

[2] As with the 6% referred to in para 4 above, the parties have for the present purpose proceeded on the basis that these local companies were paid 4%.

[3] The Decision of the Board was delivered on 12 June 2009 although the hearing had concluded on 19 January 2006.

[4] (paras 32-38) which he analyzed and rejected in paras 39-56 of his judgment. It should be noted that this reformulated case was not contained in the Commissioner's counsel's skeleton submission but was advanced orally.

[5] See clause 3 reproduced in para 5 above.

[6] Mr Yu only relied on activities (a) to (e).

[7] Mr Yu accepted that para 38 is central to the appeal. I will refer to his argument as the "para 38 argument".

[8] Mr David Milne QC and Mr Eugene Fung.

[9] Such profits may be small, given the nature of the activities which was said to have taken place in Hong Kong, because on this argument the value to be attributed to the activities carried out by the affiliates would not be confined to the 4% payable to them. Compare the Commissioner's submission before the Board outlined in paras 34 and 35 below.

[10] para 83 of ING Baring.

[11] Similar submissions were repeated in the Commissioner's skeleton submissions dated 31 March 2011 for the hearing of the appeal before Reyes J on 6 April 2011, but as Reyes J noted "not pressed".

[12] Per Bokhary PJ, see para 14 above.

[13] See footnotes 1 and 2 above. The actual figure used before the Board was 3%, on the basis that LFT was paid 7% of the FOB value and paid its affiliates 4%.

[14] That is because, according to the Commissioner, LFT's profits were not derived from the activities of its local affiliates but from its management role which took place in Hong Kong.

[15] Although he suggested that the Board had misapplied it.

[16] Including facts paras 6 and 9 referred to in para 53 above.

[17] See reasons for judgment in HCMP 541/2011 dated 20 April 2011.

COMMISSIONER OF INLAND REVENUE v. LI & FUNG (TRADING) LTD

Related cases with same parties

Files (2)

Case No	Date of Absolute Order	Date when taxation should have been commenced under rule 22(1)	Length of Delay
HCIA 3/2010	2/5/2011	2/8/2011	18.5 months
HCMP 541/2011	1/4/2011	15/7/2011	22.5 months
CACV 86/2011	2/4/2012	2/7/2012	7.5 months